University of Papua New Guinea Principles of Microeconomics Lecture 12: Monopolistic competition

The University of Papua New Guinea Slide 1 Lecture 12: Monopolistic competition Michael Cornish Overview Monopolistic competition –Short-run –Long-run –Conclusions Price discrimination

The University of Papua New Guinea Slide 2 Lecture 12: Monopolistic competition Michael Cornish Monopolistic competition: short-run Lots of firms, price-taking… so how is it different from perfect competition? Each firm in monopolistic competition faces their own downwards-sloping demand curve… –And thus a downwards sloping MR curve! –As usual, profit maximisation occurs in accordance to where MC = MR Characteristic Monopolistic competition Number of firms Many Type of product Differentiated Barriers to entry/exit Low Price taker / maker? Taker Examples of industries Hairdressers Restaurants

The University of Papua New Guinea Slide 3 Lecture 12: Monopolistic competition Michael Cornish Monopolistic competition: short-run Price Quantity Demand 0 MC Q* Profit- maximising price B A Profit-maximising quantity P* MR What other market type does it look like? Except MC ≠ supply (except when all firms’ MC curves are added together...)

The University of Papua New Guinea Slide 4 Lecture 12: Monopolistic competition Michael Cornish Monopolistic competition: short-run Profit-maximising quantity MR Price Quantity Demand 0 MC Q* Profit- maximising price B A P* ATC Profit Now adding in the ATC and calculating profit...

The University of Papua New Guinea Slide 5 Lecture 12: Monopolistic competition Michael Cornish Monopolistic competition: short-run A rather fuzzy picture of a firm experiencing losses...

The University of Papua New Guinea Slide 6 Lecture 12: Monopolistic competition Michael Cornish Monopolistic competition: long-run Just as in perfect competition, when supranormal profits are being earned in the market, more firms will enter the market However, unlike perfect competition, there are not so many firms that the demand curve they face is unchanged –The firm demand curve contracts… …AND becomes more elastic!

The University of Papua New Guinea Slide 7 Lecture 12: Monopolistic competition Michael Cornish Monopolistic competition: long-run Demand Short run MR Short run 0 MC P Short run Q Short run A Price (dollars per cup) Quantity Demand Long run MR Long run B P Long run ATC In the long-run, π = 0 Note: Point B (the long-run equilibrium) is tangential to ATC

The University of Papua New Guinea Slide 8 Lecture 12: Monopolistic competition Michael Cornish Monopolistic competition: long-run Monopolistic competition 0 Perfect competition P * D Q PC Quantity 0 Q PC MC Price P* Q MC MC MR ATC Excess capacity Quantity Price MC D=MR Productively efficient Mark-up

The University of Papua New Guinea Slide 9 Lecture 12: Monopolistic competition Michael Cornish Monopolistic competition: long-run Is the outcome of zero economic profit in the long-run inevitable? –Only if the firm does not respond So what does the firm need to try to do? –Lower costs –Differentiate its product –Engage in price discrimination

The University of Papua New Guinea Slide 10 Lecture 12: Monopolistic competition Michael Cornish Monopolistic Competition: Conclusions Productive efficiency? Allocative efficiency? Dynamic efficiency? But: –Increased consumer choice –DWL is not usually particularly large

The University of Papua New Guinea Slide 11 Lecture 12: Monopolistic competition Michael Cornish Price discrimination Price discrimination: –Similar / identical products are sold at different prices Required conditions: –Market power (i.e. not perfect competition) –Market segmentation (different willingness and ability to pay / different P ε D ) –No resale

The University of Papua New Guinea Slide 12 Lecture 12: Monopolistic competition Michael Cornish Price discrimination 3 types: 1 st order price discrimination –Δ in price according to willingness to pay 2 nd order price discrimination –Δ in price according to quantity purchased 3 rd order price discrimination –Δ in price according to location / customer segment

The University of Papua New Guinea Slide 13 Lecture 12: Monopolistic competition Michael Cornish 600 Quantity Price D ATC MC Increased profit from price discrimination st and 2 nd order price discrimination MR P* Q* 1 st Willingness to pay 2 nd Quantity

The University of Papua New Guinea Slide 14 Lecture 12: Monopolistic competition Michael Cornish 3 rd order price discrimination: the yacht diagram D1D1 MR 2 MR 1 P1P1 P2P2 MC D2D2 3 rd Location / customer segment

The University of Papua New Guinea Slide 15 Lecture 12: Monopolistic competition Michael Cornish D1D1 D2D2 MR 2 MR 1 P1P1 P2P2 MC 3 rd order price discrimination: the yacht diagram 3 rd Location / customer segment